Obligation of Contract

No State shall...pass any...Law impairing the Obligation of Con-tracts....

Article I, Section 10, Clause 1

Article I, Section 10, contains a list of prohibitions concerning the role of the states in political, monetary, and economic affairs. As the Constitutional Convention was completing its work on prohibiting states from issuing paper money as legal tender, Rufus King of Massachusetts rose to propose "a prohibition on the States to interfere in private contracts." King relied on a central provision of the Northwest Ordinance:

[I]n the just preservation of rights and property, it is understood and declared, that no law ought ever to be made, or have force in the said territory, that shall, in any manner whatever, interfere with or affect private contracts or engagements, bona fide, and without fraud, previously formed.

The Obligation of Contract Clause thus had its origins in previous national policy by extending to the states a prohibition that was already in effect in the Northwest Territory. In the brief debate that followed, George Mason feared the prohibition would prevent the states from establishing time limits on when actions could be brought on state-issued bonds. James Wilson responded that the clause would prevent "retrospective interferences only," that is, impairment of contracts already made. These comments suggest that the Framers may well have intended to limit states in their impairment of private contracts already made. But the issue is not free from doubt. The words "previously formed" were not carried over to the Obligation of Contract Clause, so that the text reads as though it has some prospective application of uncertain extent. It is therefore conceivable to apply the Obligation of Contract Clause prospectively to allow the passage of statutes of limitations, by thinking of it as a rule that protects against both retroactive and selective impairments of future contracts that would have the effect of shifting the balance of advantage from one contracting party to another.

The twin protections found in Article I, Section 10, prohibited the state from issuing paper money and, to some extent at least, from regulating economic affairs. That one-two combination troubled the Anti-Federalists, who feared that the two clauses operating in tandem would prevent the states from assisting the debtor classes. The states could no longer debase the currency with new issues of paper tender; Luther Martin asserted that the states would no longer be able "to prevent the wealthy creditor and the monied man from totally destroying the poor though even industrious debtor." In response to the Anti-Federalists, James Madison declared in The Federalist No. 44 that the Obligation of Contract Clause was essential to "banish speculations on public measures, inspire a general prudence and industry, and give a regular course to the business of society." Debtor relief was regarded as undermining the long-term stability of commercial expectations.

Support for the Obligation of Contract Clause was found in other quarters. In the South Carolina ratifying convention, Charles Pinckney argued that these two limitations on the states would help cement the union by barring the states from discriminating against out-of-state commercial interests. Edmund Randolph, in the Virginia ratifying convention, declared that the Obligation of Contract Clause was essential to enforcing the provision in the peace treaty with Great Britain guaranteeing private British debts. The Obligation of Contract Clause, therefore, served a double duty: it afforded both a protection to individuals against their states and a limitation on the states that prevented them from intruding on essential federal interests.

The language of the clause reflects these historical concerns and ambiguities. In tone, the clause reads as a stern imperative. Unlike Section 10, Clauses 2 and 3 (which relate to such matters as the imposition of duties on imports and exports), Congress cannot override the prohibition by giving its consent to any state action that violates this provision. The brief terms of the clause, however, cover more than the endless round of debtor-relief statutes the Framers had in mind, for the clause covers all types of contracts, not just debt instruments. The Framers also sought to insulate commercial exchanges from the regulatory power of the state in order to reduce the burdens on interstate commerce, and thus to contribute to the formation of the United States as an extended commercial Republic. But again the correspondence is not perfect, because the Obligation of Contract Clause applies not only to those contracts with interstate connections, but also to all local contracts.

What is clear, however, is that in the antebellum period the Obligation of Contract Clause was the only open-ended federal constitutional guarantee that applied to the states. As such, the Obligation of Contract Clause came by default to be the focal point of litigation for those who sought to protect economic liberties against state intervention. The Supreme Court's interpretation of the clause, both before and after the Civil War, has been filled with odd turns and strange surprises.

Everyone conceded that the clause applied to ordinary contracts between private persons, including partnerships and corporations. That seemed to be the understanding at the Constitutional Convention. But did the Obligation of Contract Clause also reach actions by the state so as to prevent it from repudiating its own contracts, including those that granted legal title of state owned lands to private persons, Fletcher v. Peck (1810), or which sought to revoke state charters for private colleges, Trustees of Dartmouth College v. Woodward (1819)? In both of these cases, Chief Justice John Marshall opted strongly for the broader reading of the clause in order to restrain conduct by government—reneging on grants—that would be regarded as unacceptable if done by any private individual. In this instance, moreover, the broad reach of the Obligation of Contract Clause uneasily coexisted with the principle of sovereign immunity, which Alexander Hamilton had strongly defended in The Federalist Nos. 81 and 82. That principle prevented the state from being sued for breach of its own ordinary commercial contracts. But that immunity did not allow the state to undo its own contracts once their performance was completed. This reading fits so well with the general purpose of limited government that to this day no one has rejected the view that the Obligation of Contract Clause applies to state contracts. But there has been a spirited debate as to how much protection it supplies in light of the doctrine of sovereign immunity. Certainly much is to be said on behalf of the stability of titles to property obtained in grants from the states. But we cannot ignore the reciprocal problem: if the Obligation of Contract Clause is read so broadly so as to invite groups to lobby for sweetheart agreements, reformist governments would not be able to set such agreements aside.

Most of the interpretive questions regarding the clause, however, deal with the impact of the Obligation of Contract Clause on the state regulation of private agreements, where of course the issue of sovereign immunity does not arise. That issue, in turn, is divided into two parts. The first asks whether the Obligation of Contract Clause protects the rights that are vested in contracts that are in existence at the time the regulation is passed. The second asks whether the Obligation of Contract Clause imposes limitations on the power of the state to regulate contracts not yet established. The answer to the first question is relatively uncontroversial. The clause must apply to preexisting contracts, for otherwise it would be a dead letter. Hence, early decisions held that state insolvency laws could not order the discharge of contracts that were formed before the state statute was passed. Sturges v. Crowninshield (1819). The legislature could not flip the background rules of the legal system to the prejudice of individuals who had advanced money on the faith of earlier arrangements. The clause also applied to a wide range of debtor-relief laws, wherein individuals sought to escape or defer the payment of interest, or to avoid foreclosure of their mortgages in hard economic times. It was, however, one thing to say that the Obligation of Contract Clause applied, and quite another to say that all forms of debtor relief were regarded as beyond the power of the state. Many cases adopted the slippery distinction that the Obligation of Contract Clause preserved the obligation under contract, but did not prevent the state from limiting one or another remedy otherwise available. Small erosions of contract rights were regarded as permissible, but large deviations were not, even though the clause speaks of all impairments (large or small) in the same breath. But in general, the prohibition against state intervention into existing contracts holds unless (as will be discussed later) the state offers some police-power justification for its actions.

The Court reached a much more definitive conclusion on the second question in 1827, by holding in Ogden v Saunders (4–3, with John Marshall and Joseph Story dissenting) that the Obligation of Contract Clause did not apply to those contracts that had not been formed as of the date of the passage of the legislation. In one sense, the decision is surely unexceptionable, for it would be odd if a revision of, say, the parol evidence rule in 2000 could not apply to any contracts signed before that date. The rule itself does not bias the case one way or another, but it is intended to improve the overall administration of justice. Individuals typically do not rely on these rules at formation, either. It would be contrary to its original design to read the Obligation of Contract Clause as blocking any improvements in the administration of commercial justice.

By the same token, the broad refusal to apply the Obligation of Contract Clause prospectively could go too far. For example, suppose a state just announced that from this day forward it reserved the right to nullify at will any contracts that were thereafter formed. At that point, it would take only a short generation after passage of this statute to gut the Obligation of Contract Clause. But if that stratagem is forbidden, then the clause must have some prospective application, notwithstanding intimations in the Convention that it only had retroactive application. At this point, one way to read the clause is to hold that its prohibitions are prospective but not absolute. The state may alter the rules governing future contracts only in ways that offer just compensation to all contracting parties in the form of greater security and stability in their contractual obligations. The three legislative reforms that arose most frequently in the early debates—a statute of frauds, a statute of limitations, and recording acts—are all measures that meet this standard.

By refusing to give the clause any prospective role, Ogden opened the gateway to partisan legislation that limited the ability of some parties to contract without imposing similar restrictions on their economic competitors. In practice, Ogden meant that all general state economic regulation lay outside the scope of constitutional limitation. That gap in the system of constitutional regulation remained until after the Civil War, at which time some protection against state interference with future contracts was supplied under the so-called dormant Commerce Clause (with respect to interstate agreements only) and under the doctrine of liberty of contract as it developed under the Due Process Clause, and, in certain limited cases, under the equal protection clauses. But since Ogden, the Obligation of Contract Clause has been an observer, not a central player, in the constitutional struggle to limit prospective state economic regulation.

The Obligation of Contract Clause does continue to have some traction with respect to contracts previously formed, but even in this context, two types of implied limitations on its use have been introduced: the just-compensation exception and the police-power exception. In principle, the initial question is why any implied terms should be read into any constitutional provision, when no mention of them is made by the Framers. Here the simplest answer is that the logic of individual rights and liberties requires that adjustment. The Constitution thus creates presumptions and leaves it open to interpretation as to how these should be qualified in ways that do not gut the original guarantee.

Consider first the question of property takings with just compensation. Suppose that A buys land from B, which the government then wishes to condemn with payment of just compensation. Surely the government's right to condemn is not blocked by A's declaration that he received absolute title to the property from B. The standard rule is that the power to take property for public use is "inherent in government," so that the condemnation can go forward. Should there be any difference when A buys the land from the government, instead of B, and now claims that the government cannot go back on its grant? As early as 1848, in West River Bridge Co. v. Dix, the Supreme Court allowed the condemnation to go forward. The Obligation of Contract Clause has to be read subject to a just-compensation exception, for the condemnation does "impair" the contract right by denying the owner's right to hold out for an above-market price. Reading the just-compensation exception into the Obligation of Contract Clause does not do violence to a structure that already allows other private property to be taken for public use upon payment of just compensation.

The second set of exceptions to the Obligation of Contract Clause involves the police power. Again, this power is nowhere mentioned explicitly in the Constitution, but it is read in connection with every substantive guarantee that it supplies against federal or state power. The customary formulation allows the state to override (without compensation) private rights of property. It should, therefore, do so with ordinary contracts as well. Nonetheless, because no compensation is provided, logically, the class of justifications should be more stringent than the public-use requirement that allows the impairment of contracts with compensation. The canonical formulation defines the state police power as regulation in the name of safety, health, morals, and the general welfare. Stopping contracts to pollute, to bribe, or to fix prices has always been held to fall within the police-power exception. The New Deal constitutional transformation of 1937, however, greatly expanded the scope of the police power beyond these broadly libertarian objectives, so that it no longer was possible to distinguish between general welfare and special interests.

The great transitional case of Home Building & Loan Ass'n v. Blaisdell (1934) is notable for ushering in an era that allowed courts to multiply the police-power exceptions to the contractual guarantees offered by the Obligation of Contract Clause, even when no compensation was supplied. The actual decision, dealing with a state-imposed mortgage moratorium, could be explained in part as an effort to counter the ruinous effects of deflationary policies (which in effect increased, in constant dollars, the amount of the debts), but the decision itself was cast in broader terms and unleashed many other legislative initiatives that sought to neutralize the protections secured by individual contracts. Most notably, in Exxon Corp. v. Eagerton (1983), the Court found that a "broad societal interest" was sufficient to justify a decision to prevent a company from asserting its explicit contractual right to pass on any increased severance tax to its consumers.

At present, therefore, it is doubtful whether the Supreme Court will find a police-power justification for any piece of special legislation with interest-group support, thereby gutting the clause insofar as it applies to broad classes of existing contracts. Ironically, however, the Court has remained more suspicious of government's efforts to use legislation to extricate itself from its own covenants, noting the obvious risk of self-dealing that this behavior represents. It thus struck down efforts of the Port Authority of New York and New Jersey to nullify bond covenants that prohibited it from using bond proceeds to support mass transit. United States Trust Co. v. New Jersey (1977). And in Allied Structural Steel Co. v. Spannaus (1978), the Court refused to allow Minnesota to impose retroactively more-stringent financial obligations on an employer in the winding up of its pension plan. These limitations on state power notwithstanding, the modern age often finds little intellectual respect for freedom of contract or for the sanctity of contracts validly formed. More than any fine point of the law, that initial intellectual predilection explains the lukewarm reception that Obligation of Contract Clause claims receive in the current legal environment.